2016! What a year!

Stocks took a huge dive last January bottoming out on February 11th, down about 11.5% for the first six weeks of 2016. Predictions were that Fed Chair Yellen was going to raise interest rates many times. That never happened. On January 12th, U.S. oil broke below $30 per barrel, down from $107 just 18 months earlier.

Fast forward to November 8th. Stock futures dropped nearly 700 points in overnight trading as election returns reflected Donald Trump would win the presidential election. By the opening bell at 9:30 am the next morning the decline had reversed and stocks would open up 200 points. The year 2016 ended with the S&P 500 up 9.5%, the majority of the gains coming since the presidential election. Stocks are expensive by any measure.

S&P 500 2016

As we get into 2017, there are a few themes evolving, some quite conflicting. Plans are for taxes to be cut for all income levels. The maximum rate would be cut from 39.6% to 33% according to Trump’s plan. The other two rates would be 12% and 25%. At the same time our national debt is projected to continue its glide higher and higher beyond the $20 Trillion benchmark. Some economists think the tax cuts and increased spending plans put forward by the Trump team may trigger higher inflation and force the central bank to raise rates more aggressively.

J.P Morgan comments, “The prospects of pro-growth policy reforms under the Trump administration (i.e., deregulation, tax reform, fiscal spending) should continue to push the market higher…However, rising yields and USD are the main risks to our positive equity outlook. This week’s incrementally hawkish tone from the FOMC meeting is raising the hurdle for both expanding equity multiple and corporate profitability. … Historically, a 6% rise in trade-weighted USD pressures S&P 500 EPS by roughly 2-3%.”

Goldman, Merrill and Morgan Stanley, oddly enough, all have a consensus for the S&P 500 to rise only 2% in 2017!

What about those rising interest rates? Long dated (30 years) Treasury, municipal and corporate bonds have been hammered with price declines of as much as 20+ percent because of rising rates. The yield on the 10-year U.S. Treasury has risen from 1.35% last July to as high as 2.6% last month. A nice 92% increase in yield. Bill Gross of Janus recently commented, “If 2.6 percent is broken on the upside … a secular bear bond market has begun,” Gross said. “Watch the 2.6 percent level. Much more important than Dow 20,000. Much more important than $60-a-barrel oil. Much more important than dollar/euro parity at 1.00. It is the key to interest rate levels and perhaps stock prices in 2017.” He went on to say, ” the 10-year yield has been in a downward trend line since 1987. If that channel is broken, look out.

10-Year U.S. Treasury Yield July 2016 – December 2016

America is driving the global political risk and uncertainty right now. U.S. foreign policy, protectionism, rising interest rates and the U.S. dollar strength are huge issues without answers going forward.

We have an inauguration on January 20th for a new president. We believe that day will be a pivotal point for the markets and set the tone for the remainder of 2017. We shall remain cautiously optimistic on the future but suspect volatility will return with a vengeance creating better opportunities to buy into great companies at better prices.

J. Brock Hamilton
January 10, 2017